In a series of three “no-action” letters, the staff of the Securities and Exchange Commission (SEC) published guidance to address concerns by U.S. broker-dealers and investment advisers about how to comply with Markets in Financial Instruments Directive (MiFID II) rules that limit the use of soft dollars.  Among other things, the Division of Investment Management said that broker-dealers, on a temporary basis, may receive research payments from money managers in hard dollars or through MiFID II governed research accounts from clients subject to MiFID II, without being considered to be an investment adviser.

After consulting with European regulators, the SEC staff published the guidance in response to concerns that U.S. broker-dealers that must comply with MiFID II soft dollar limitations would be forced to register as investment advisers if they provided research for hard dollars.  The long-awaited guidance provides some clarity for financial institutions faced with the dilemma of how to comply with conflicting U.S. and EU regulatory requirements.

The temporary action provides the SEC a breather to “monitor and assess” the impact of MiFID II’s requirements on the research marketplace and whether any new rules are needed.

The European Union’s (EU) recast MiFID II, which kicks in on January 3, 2018, effectively eliminates the ability of EU clients to pay broker-dealers for research services through “soft dollars.”  Section 28(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) provides safe harbor for a money manager to use client commissions to purchase “brokerage and research services” without breaching its fiduciary duty.  In the U.S., money managers often use client commission arrangements to obtain brokerage and research services from a broker-dealer, using a single, “bundled” commission that is separated after execution to pay for order execution and research.  Broker-dealers can provide this research to advisers without having to register as investment advisers if the research is incidental to their brokerage business.

The Division of Investment Management also provided relief under the Investment Company Act of 1940 and the Advisers Act to permit investment advisers to continue to aggregate client orders for purchases and sales of securities, when some clients may pay different amounts for research because of MiFID II requirements, but all clients will continue to receive the same average price for the security and execution costs.  This relief allows advisers to continue to aggregate orders while addressing the differing arrangements regarding the payment for research that will be required by MiFID II.

MiFID II permits money managers to pay an executing broker-dealer for research out of a client-funded research payment account (RPA) alongside payments for order execution.

The Division of Trading and Markets said that U.S. money managers may operate within the safe harbor if they pay for research to an executing broker-dealer out of client assets alongside payments for execution through the use of an RPA that conforms to the requirements for RPAs in MiFID II, and the executing broker-dealer is legally obligated to pay for the research, provided that they meet the conditions of the Section 28(e) safe harbor.

The SEC has invited market participants to visit its website and comment on the issues.

Our Take

The long-awaited guidance from the SEC takes a practical approach that acknowledges the conundrum faced by U.S. advisers and broker-dealers that must comply with conflicting U.S. and EU requirements.  The actions solve the immediate issue while leaving open the door for future regulation once the SEC wraps its regulatory arms around how the U.S. and EU laws will work in practice and how they affect the capital markets.  Also, this approach signals that the SEC and its staff are mindful of the need for regulation while recognizing that regulations must be practical and flexible.

New FINRA Rule 2241 covering equity research reports and analysts and new FINRA Rule 2242 covering debt research reports took effect less than a year ago in December 2015 and July 2016, respectively; and market practice with respect to compliance with the new research rules continues to evolve.

Our updated FAQs on the separation of research and investment banking are intended to help explain (1) the main requirements of new research rules, (2) how firms can comply with the new research rules and the related safe harbors, (3) recent FINRA guidance on the new research rules, and (4) related SEC rules and guidance and JOBS Act implications.

See our updated FAQs available at: https://media2.mofo.com/documents/frequently-asked-questions-about-separation-of-research-and-investment-banking.pdf.

Wednesday, October 19, 2016
12:00 p.m. – 1:00 p.m. EDT

Morrison & Foerster Partners Marty Dunn and David Lynn will host a teleconference entitled “Sending Your Message: Communications Rules for Offerings.” During this session, we will focus on the SEC’s communications rules applicable to public and private companies when they are engaged in securities offerings. We will discuss:

  • Materiality;
  • Press releases;
  • Research reports;
  • Non-deal roadshows;
  • Free Writing Prospectuses;
  • Regulation FD; and
  • General solicitation and general advertising, revisited.

CLE credit is pending for California and New York.

To register for this session, or for more information, please click here.

On June 24, 2016, FINRA proposed amendments to its communications rule, Rule 2210, to help clarify the application of Rule 2210 to debt research reports, in light of the new debt research rule, Rule 2242.  The implementation date for the proposed amendments is July 16, 2016, which is the current effective date for Rule 2242.

The proposed amendments help clarify Rule 2210 in four main respects.  First, the proposed amendments would (1) streamline the scope of approval permitted by supervisory analysts to specifically reference the definition of “debt research report” in Rule 2242(a)(3) and (2) add a specific reference to the exceptions to such definition under Rule 2242(a)(3)(A), thus making the references to debt research-related retail communications consistent with the references to equity research-related retail communications.  The proposed amendments also would maintain the ability for a supervisory analyst to approve other research communications (e.g., research on options), provided that the supervisory analyst has technical expertise in the product area and any other required registrations for such product.  Second, the proposed amendments would make the exception from pre-use approval requirements under Rule 2210(b)(1)(D)(i) consistent for debt and equity research communications.  Third, the proposed amendments would (1) except debt research reports from the disclosure requirements of Rule 2210(d)(7) (applicable to retail communications that include a recommendation of securities) and (2) except public appearances by debt research analysts from the disclosure requirements of Rule 2210(f)(2) (applicable to an associated person recommending a security) for consistency purposes.  Fourth, the proposed amendments would make technical changes to Rules 2210(d)(7) and (f)(5) to make the rule language more readable.

The text of the proposed amendments to Rule 2210 is available at:  http://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2016-021.pdf

On April 27, 2016, the House of Representatives passed the Helping Angels Lead Our Startups Act (H.R. 4498) (the “HALOS Act”), which was first introduced on April 16, 2015.  The HALOS Act directs the SEC to amend Regulation D under the Securities Act to make the prohibition against general solicitation or general advertising inapplicable to events with specified sponsors (including angel investor groups not connected to broker-dealers or investment advisers) where:

  • presentations or communications are made by or on behalf of an issuer;
  • the advertising does not refer to any specific offering of securities by the issuer;
  • the sponsor does not engage in certain activities (such as offering investment recommendations or advice to attendees); and
  • no specific information regarding a securities offering is communicated (other than that the issuer is in the process of offering or planning to offer securities, including the type and amount of securities being offered).

In addition, the HALOS Act (1) limits the types of fees ‘‘demo day’’ sponsors can collect (cannot receive any compensation for making introductions between investors attending the event and issuers, or for investment negotiations between such parties), (2) limits attendance at “demo days” to only individuals with financial sophistication (members of an angel investor group or accredited investors), and (3) requires that an issuer not be in bankruptcy or receivership, an investment company, or a blank check, blind pool or shell company.  H.R. 4498 is available at:  https://www.congress.gov/114/bills/hr4498/BILLS-114hr4498rh.pdf

The HALOS Act would incorporate into regulation issues as to which the SEC Staff already has provided guidance either in the form of no-action letter guidance (on demo days, for example) or in Compliance and Disclosure Interpretations.

On April 21, 2016, the Fair Access to Investment Research Act of 2016 (H.R. 5019) (the “Fair Access to Investment Research Act”) was introduced in the House of Representative.  The Fair Access to Investment Research Act directs the SEC to amend Rule 139 under the Securities Act to provide that a covered investment fund research report that is published or distributed by a broker-dealer will be deemed, for purposes of Sections 2(a)(10) and 5(c) of the Securities Act, not to constitute an offer for sale or an offer to sell a security that is the subject of an offering pursuant to a registration statement that is effective (even if the broker-dealer is participating or will participate in the registered offering of the covered investment fund’s securities).  H.R. 5019 is available at:  https://www.congress.gov/114/bills/hr5019/BILLS-114hr5019ih.pdf

On February 16, 2016, FINRA proposed delaying the implementation date of its new debt research rule (Rule 2422) until April 22, 2016.  Currently, Rule 2422 is set to take effect on February 22, 2016.  We will monitor developments relating to the implementation date of Rule 2422 on this blog.

The proposed FINRA rule change is available at http://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2016-008.pdf.

On February 9, 2016, Anna Pinedo and Ze’-ev Eiger gave a presentation on FINRA’s final equity research rule and new debt research rule.

The complete materials from the presentation are available at http://www.mofo.com/~/media/Files/Presentations/2016/02/160202FINRAResearchRules.pdf.

Our client alert on the final FINRA research rules is available at http://www.mofo.com/~/media/Files/ClientAlert/2016/01/160125FINRAFinalEquityDebtResearchRules.pdf.

Our research quick guide to offerings, which is in the form of a flow chart, also is available at http://media.mofo.com/files/Uploads/Images/Research-Quick-Guide-Offerings.pdf.

In addition, our tracking chart for the final FINRA research rules, comparing the final equity research rule with the new debt research rule, is available at http://www.mofo.com/~/media/Files/documents/2016/02/160211FINRATrackingChart.pdf.

Many market participants were left in a quandary following FINRA enforcement actions in connection with member firm research analyst “participation” in meetings with prospective issuers.  Recently, FINRA published a handful of Frequently Asked Questions relating to its research rules (see:  http://www.finra.org/industry/faq-research-rules-frequently-asked-questions-faq).  The FAQs outline three stages of an IPO a pre-IPO period, a solicitation period, and a post-mandate period.  Each such stage is described in the FAQs and FINRA also describes the attendant risks associated with a research analyst’s activities during these various stages.  Of course, during the pre-IPO stage, the attendant risks are attenuated and FINRA believe that these attenuated risks can be addressed adequately through properly designed policies and procedures.  However, FINRA cautions that member firms ought to be sensitive to any communications that would suggest the issuer already had determined to proceed with an IPO.  The guidance also provides FINRA’s view regarding when the “solicitation period” would be deemed to begin, although this would seem, in real life, to be a highly fact-specific matter.  In the post-mandate period, again, the risks are attenuated, in FINRA’s view, and may be effectively addressed by member firms through their policies and procedures.  The guidance is particularly strident with respect to valuation analyses.  For example, the FAQs note that a member firm that is competing for an IPO role must repudiate any communication that would seemingly indicate that a valuation reflects the analyst’s views and expressly note that the firm cannot make any representations about the analyst’s views on valuation.

In November 2014, and further amended in February 2015, FINRA announced a comprehensive revision of the equity research rule currently numbered as NASD Rule 2711 and proposed a debt research rule modeled on the equity research rule.  The equity research rule would be numbered FINRA Rule 2241 and the debt research rule would be numbered FINRA Rule 2242.  The amended rule proposals can be found here: SR-FINRA-2014-047 (equity) and SR-FINRA-2014-048 (debt).  The structures of the two rules are very similar but there are important differences.  To guide your analysis of the two rules, here is a link to a line-by-line comparison of the two rules.

We invite you to download a free copy of the updated edition of our book, or to request free hard copies for you and your colleagues.

Foreign Banks Financing in the United States, published by IFLR, provides a timely discussion of the approaches used by foreign banks to raise capital from US investors.

Foreign banks may rely on exempt offerings, such as 4(a)(2) offerings, 144A/Reg S offerings and 3(a)(2) offerings, or registered offerings to issue securities to US investors. We discuss each of the possible offering formats, as well as the practical considerations for issuers and their intermediaries when establishing or accessing a medium-term note program, a commercial paper program, a covered bond program, or a structured products program.

As foreign banks contemplate the potential need to raise additional capital, this guide offers an overview of regulatory consideration.

To download the book, please click here.

To request hard copies, please email Alexa Powers at alexapowers@mofo.com.

Any milestone, such as an anniversary, provides an opportunity for reflection and evaluation.  At the one-year anniversary of the JOBS Act, preliminary experience gives reason for some optimism.  The centerpiece of the JOBS Act, the “IPO on-ramp” provisions contained in Title I, have proven quite useful.  The SEC Staff’s guidance in the form of Frequently Asked Questions (or FAQs) promptly filled the gaps in the legislation and helped facilitate prompt reliance on these new provisions.  It would be too soon to draw conclusions regarding the impact of the on ramp on IPOs in general, and smaller IPOs in particular.  The provisions relating to the Exchange Act threshold, which also were immediately effective, have already been relied upon by many smaller banks to suspend their ongoing reporting.  Most of the other provisions of the JOBS Act await further SEC rulemaking.  Below we provide a very brief “cheat sheet” of the status of the various provisions.  We believe that it is fair to say though that the JOBS Act has already had a profound effect on capital formation by restarting an important dialogue on SEC disclosure requirements and permissible communications that seemed to come to an end just after the Securities Offering Reform in 2005, when attention turned to executive compensation disclosures, corporate governance concerns, and ultimately the financial crisis.  The JOBS Act also has served to bring greater general awareness of the important changes that have taken place in the last decade in the way that promising companies choose to finance their growth.  Finally, even for the non-securities lawyers among us, the JOBS Act has focused attention on the divide between public and private offerings—challenging all of us to think more closely about the appropriateness of certain existing regulations that seem more and more “artificial” in the face of social media and other developments.

Title I (the IPO on-ramp)

  • This Title was immediately effective, so no SEC rules were required for this title to take effect.
  • The “IPO on-ramp” provisions generally have proven helpful for companies undertaking IPOs:
    • The SEC Staff immediately put out guidance in the form of FAQs.
    • Market participants have been cautious in relying on some of the accommodations available to EGCs; however, over time, market practice may shift.
    • Most EGCs are still presenting three years of financial information (instead of the permissible two years).
    • Most EGCs are taking advantage of the ability to present abbreviated executive compensation disclosures.
    • Most EGCs are taking advantage of the ability to submit their IPO registration statements for confidential review by the SEC, and relying on the confidential process for at least one or two rounds of SEC comments, before the first public filing.
    • EGCs also are benefiting from the delayed phase-in of other costly compliance requirements, like the Sarbanes 404 attestation requirement.
    • Now, at the one-year anniversary, a fair number (just over 100) of EGC IPOs have been completed.
    • Statistics indicate an increase in smaller IPOs, which, in part, was one of the desired outcomes of the JOBS Act.
  • In addition to providing a new approach for EGC IPOs, Title I also addresses analyst research issues, and requires that the SEC undertake several studies.
  • Research
    • Even after the JOBS Act, the unlevel playing field remains as to research, as a result of the Attorney General Settlement, the terms of which have not been modified.
    • FINRA modified its rules in accordance with the JOBS Act.
    • Most investment banks now have settled (informally) on a 25-day post IPO quiet period before publishing research following completion of an IPO.
    • There is no evidence that investment banks are interested in releasing pre-deal research reports for EGCs.
    • Additional regulatory changes would be needed in order to promote additional research coverage for EGCs.
  • Studies
    • The SEC published the required decimalization study and held a decimalization roundtable; a consensus has formed that a pilot program should be initiated for larger tick sizes.
    • The required study on Regulation S-K has not been delivered.

Title II (Private placements)

  • The SEC proposed rules in August 2012 to carry out the JOBS Act mandate to relax the ban on general solicitation
    • The comment period closed in October 2012; however, the rules have not been finalized.
    • There was vigorous comment on the SEC’s proposed rules, with some commenters advocating the adoption of a safe harbor relating to the measures that would be deemed “reasonable” to verify the status of investors; the adoption of content restrictions or guidelines for materials used in general solicitation; and a reexamination of the “accredited investor” threshold.
    • We anticipate that the SEC will seek to finalize the rules in the spring, and seek to finalize the “bad actor” provisions (required to be adopted for Rule 506 offerings by the Dodd-Frank Act) contemporaneously
  • Matchmaking sites
    • There were no rules needed in respect of the broker-dealer registration exemption for matchmaking sites
    • The SEC Staff put out guidance in the form of FAQs addressing various matters relating to the types of entities that might engage in these activities without subjecting themselves to broker-dealer registration.
    • The SEC Staff issued two no-action letters addressing the applicability of the exemption in the context of VC platforms.

Title III (crowdfunding)

  • No SEC rule proposal as yet (SEC missed deadline)
    • The SEC Staff published FAQs regarding the crowdfunding exemption.
    • FINRA has provided a form for collecting information about funding portals.
    • Concerns remain about the extent to which the crowdfunding exemption as contemplated by the JOBS Act could be used by ventures to raise small amounts of capital in a cost-efficient manner.

Title IV (Regulation A+ or Section 3(b)(2))

  • No SEC rule proposal as yet.
  • Now, pending legislation would mandate that the SEC take action by a date certain.

Titles V & VI (Exchange Act threshold)

  • These provisions relating to the Exchange Act threshold were immediately effective; SEC rulemaking was not required.
  • Many banks (over 100, according to published reports) have taken advantage of these provisions to suspend their SEC filings.
  • The SEC is expected to provide guidance regarding various “holder of record” issues.

What should you expect in the coming months?  We anticipate that the SEC will move ahead with finalizing the rules required under Title II to address general solicitation in certain Rule 506 and Rule 144A offerings.  We expect that this will be accompanied by the final “bad actor” rules required under the Dodd-Frank Act.  The discussion about general solicitation is likely to cause the SEC to revisit the “accredited investor” definition—perhaps resurrecting parts of the SEC’s 2007 “larger accredited investor” standard.  Given the complexities to be addressed by the SEC and FINRA in connection with creating a framework for crowdfunded offerings and funding portals, we anticipate that a proposal relating to crowdfunding may not be released until the second half of 2013.  As we have already seen from meetings of various advisory committees, more attention likely will continue to be focused on rationalizing the disclosure requirements and the communications rules applicable to smaller public companies and companies that might have qualified for EGC status (but for the date of their initial offering of equity securities).  Given the higher registration thresholds under the Exchange Act, we may continue to see the development of a trend toward staying private longer, and the growth of markets designed to provide liquidity to investors in those companies.  Given the press of other business under both the JOBS Act and the Dodd-Frank Act, we may not see a proposal for exempt public offerings under Title IV in 2013.  Lastly, we would hope that the momentum toward encouraging capital formation that was created by the JOBS Act will not be lost in its second year of existence, and we will instead see continued dialogue—coupled with regulatory and market action—that is oriented toward creating opportunities to put capital to work companies of all sizes.